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OED kicks off City of San Jose Opportunity Zones dialogue

/ February 22, 2019 by Nathan Donato-Weinstein

There’s a lot of buzz right now around Opportunity Zones – a new federal tax incentive for investment in lower-income communities. With 11 designated Census tracts, San Jose has the most Zones in Silicon Valley, and investors have responded by looking for deals throughout the new Zones, especially in Downtown.

But what does the Opportunity Zone designation really mean? How does it align with the city’s goals and priorities for housing development, equitable growth, and economic activity?

We probed these and other questions at a February 4 workshop that convened tax experts, state officials, investors, nonprofits, businesses, and other stakeholders. Because we filmed the event, we’re able to make the conversation available to anyone looking to better understand the issues at play. (Scroll to the end of this blog post for links to the event resources, including a package of information on San Jose’s Opportunity Zones.)

As a City, San Jose doesn’t have a formal implementation role under the Opportunity Zone statute, which was included in the 2017 Tax Cuts and Jobs Act. But we are keenly interested in facilitating investment that helps fulfill the city’s General Plan, grows housing opportunities, activates transit, and increases jobs. The following are some key takeaways from the workshop:

Opportunity Zones aren’t just for real estate: Investing in operating businesses is at the heart of the business models of Blueprint Local and Launch Pad, whose executives described their visions at the workshop. These innovative companies aim to take equity stakes in startup businesses (including small businesses) located in Opportunity Zones, revitalizing once-neglected street corners and corridors.

That’s potentially a big deal for companies looking to access new sources of capital. And because San Jose’s Zones are so typologically varied, that means almost any kindof business could potentially find a suitable type of space – whether it’s a small retailer, commercial kitchen operator or advanced manufacturer. As tax expert Michael Novogradac told the audience, “Every business that’s thinking of starting needs to be thinking, should I start this business in an Opportunity Zone?”

But there’s a lot we don’t know yet. Because the federal regulatory guidance has taken longer than expected, crucial questions remain about a business’s potential qualifications, so it’s not clear just how much traction this use case will get.

The jury’s also still out on affordable housing, but it deserves emphasis. There’s definite interest in how affordable housing developments could make use of Opportunity Zones. But as nonprofit MidPen Housing’s Jan Lindenthal explained, it’s not at all clear that Opportunity Fund investors will want to fund affordable deals, given higher returns available elsewhere. One area of potential promise? “Missing middle” housing, for people who make too much for traditional subsidized housing but too little to afford market rents. “We’re working really hard to figure out how to address this missing middle,” she said. “In order to serve that group we’ve got to find nontraditional sources of capital. The reason we’re actively engaged in exploring Opportunity Zones and how they can be applied to that is to crack that nut.”

An evolving ‘state’ of play: Gavin Newsom’s 2019-2020 budget proposal includes language that would partially conform state tax law in the case of investments in green technology or affordable housing, but so far there are few details. More action is possible: The Governor’s office said it is “exploring layering additional programs on Opportunity Zones and EIFDs (Enhanced Infrastructure Financing Districts) to increase the production of affordable and moderate-income housing.”

The early bird gets the (Opportunity Zone) worm. Because of some critical timelines built into the law, real estate projects that are closest to approval (or through major milestones) are better positioned to attract capital under the incentive. With this in mind, it’s critical that investors undertake robust due diligence to understand ahead of time what issues might pop up and develop a realistic timeline.

We think downtown is well positioned to benefit. We have seen a lot of interest and entitlement activity in Downtown, but because of construction costs it’s still remarkably hard for developers to attract capital and actually get projects built. We did a study a couple months ago that found projects in most areas of the city had a real hard time penciling out. Link to cost of development agenda/docs?

Keeping residents’ needs front and center. Displacement is a growing concern across the region as rents have risen faster than wages. By definition, Opportunity Zones include high proportions of low-income residents, and a San Jose analysis shows 67 percent of residents in these Zones are renters, compared to 43 percent citywide. At the same time, San Jose’s General Plan anticipates strong housing and job growth across the city, including in areas recently granted Opportunity Zone designations (especially in Downtown).

Against this backdrop, the City is working to develop an anti-displacement strategy for both small-business and residential tenants. The residential anti-displacement work will identify the neighborhoods that are experiencing displacement, and evaluate tools that balance housing production, housing preservation and tenant protection in areas in the path of growth.

The other key element in all of this is providing access to jobs that support working residents. To that end, the strategy for San Jose’s light- and heavy-industrial zones is to encourage additional job growth that supports middle-skilled workers through manufacturing or other industries.

Learn more about San Jose’s Opportunity Zones with the following resources: